How to pay for o new machine tool con be as complex on issue as deciding which machine tool to buy.
Do you remember what financing a machine tool was like in the mid-1980s? In those days, financing was a very slow and cumbersome process! Overnight deliveries and fax machines were hard to come by. Not only did it take days for the preparation and mailing of financial data, but it took even longer for an answer from the finance source in most cases. Once you received an approval and you agreed with the terms, even more days were lost while waiting for documents to be prepared. In addition, the basic products that were provided 15 years ago were usually a $1.00 purchase option, a 10-percent purchase option and the "dreaded" Fair Market purchase option. There simply were not the same financing options available then that there are today.
Imagine your company has decided to finance a piece of manufacturing equipment. It could be a five-axis machining center, a turn-mill machine or a creepfeed grinder. Do you lease it, buy it or rent it? Are there tax implications? Does it really make a difference how you finance it?
The answer to these questions can only be determined after analyzing your company's particular circumstances. Let me illustrate how your company can acquire the same piece of equipment using several different finance structures and at the same time have the "cost" to you be identical.
(Assume an equipment cost of $250,000 with a 10-percent yield (APR) over 60 months with no up-front payments or money down.)
Structure #1: A loan or $1.00 purchase option lease. Payment amount is $5,311.76. Total of payments equals $318,705.60.
Structure #2: A finance lease with a 10-percent purchase option. Payment Amount is $4,988.92. Residual due at end of lease is $25,000. Total of payments is $324,335.20.
Structure #3: A finance lease with a 20-percent purchase option. Payment amount is $4,666.08. Residual due at end of lease is $50,000. Total of payments is $329,964.80
Structure #4: A true lease (Fair Market Value purchase option). Payment Amount is $4,002.03. Total of payments is $240,121.80 The equipment is owned by the lender, and your company would expense the payments on the Profit and Loss statement. The purchase option is the Fair Market Value of the equipment at the end of the lease. You could purchase or return the equipment at the end of the lease term.
As you can see, the structures are all different in terms of the actual dollars paid by your company. However in terms of actual cost (yield), structures 1-3 above are identical! This is because of the timing of the payments made to the lender. Another factor that potentially impacts the true economic cost to your company is the accounting treatment given to the transaction. Your accountant may choose to "expense" the payments on the lease and not account for the depreciation and interest under a purchase scenario. This option will likely affect your tax rate.
Given the above, I would like to further illustrate and explain how many services and structures are available when purchasing equipment today. This will help your company decide what your best options are when it comes to financing an asset in the future.
What is A Lease?
A lease is a contract in which one party conveys the right to use an asset to another party for a specified period in exchange for a specified stream of payments. At the end of the lease term, the lessee usually either purchases the asset (by exercising the Purchase Option) or returns it to the lessor.
Leases can be structured in several different ways.
$1.00 Buyout Lease. This is the most commonly used leasing structure. It provides the rights of ownership to the lessee. The asset(s) will be capitalized on the lessee's books, allowing the lessee to expense the depreciation and interest on his or her profit-and-loss statement. This structure requires the highest monthly payment over the term, and the customer then "buys" the asset for $1.00.
Fixed Price Purchase Option (Finance Lease). This structure allows the lessee to purchase the equipment for a preset percentage of the original equipment cost (such as 10 percent, 15 percent and so on). Fixed price options are usually structured to give the lessee lower monthly payments (compared to a $1.00 buyout lease, for example) while still retaining the rights of ownership. At the end of term, the lessee can return the equipment, buy it for the preset amount or finance the option. The lessee depreciates the equipment and deducts interest payments in the same manner as the $1.00 buyout lease. It is generally believed that less than a 20-percent Fixed Price purchase option would allow for the lessee to retain ownership. However, you should always consult your tax advisor concerning the tax consequences of a lease with a Fixed Price purchase option.
Fair Market Value Lease (FMV or True Lease). Typically, an FMV lease product allows for the lowest monthly payment among the leases offered. The payments are usually fully tax-deductible (same as a rental). At the end of the term, the lessee would buy the equipment for its current Fair Market Value, return the equipment or renew the lease. Many companies utilize this structure to their advantage.
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